Enhanced Indexation, Global Equity

Client-Specific Concerns

This Middle Eastern Family Office was seeking to add enhanced indexation to a public equity portfolio that had previously been fully invested in passive strategies. They sought experienced, well-established fund managers with a strong track record in the space to deliver consistent outperformance with ex-ante tracking error of 1.5%. It is worth noting that broader bfinance client demand for enhanced indexation has been strong in this period. This activity has been supported by robust performance and was discussed in a bfinance Insights article: ‘Enhanced Indexation’ Gains Momentum as Investors Shift Gears.

bfinance value-add:

• Assessing performance consistency. Although enhanced indexation strategies do not seek to deliver an overall tilt in favour of one particular style or factor, such as ‘value’ or ‘momentum,’ they do rely on balanced exposure to multiple factors in order to generate alpha. As such, they may still struggle in certain market environments due to the drag from specific factor exposures. The swings and reversals in factor performance over the past few years provide an excellent opportunity to assess fund managers’ approaches and evaluate ability to deliver consistent alpha over both short- and long-term horizons. Robust risk controls have proven essential in mitigating the risk of underperformance.
  
  
• Beyond factors: looking at other sources of alpha. A notable (and growing) subset of strategies in this sector leverage alternative data and machine learning/AI techniques to support alpha generation. These are intended to supplement the more conventional multi-factor approaches. Use of such techniques can arguably offer diversification benefits in portfolio construction and help to mitigate ‘factor crowding’. That being said, it is important to separate ‘spin’ from substance when considering newer methodologies.
  
  
• Portfolio construction and strategy combinations. With a view to developing a robust portfolio, the prospective strategies were considered both on their own merits and, in addition, as potential components in a multi-manager framework. Combination analysis based on investment approaches and performance track records helped to highlight potential complementarity between the six shortlisted managers.
  
  

Figure 1: Three-year performance and tracking error for six shortlisted strategies (and combinations)

Source: bfinance, 2024

Figure 2: Excess returns of global enhanced equity strategies vs. MSCI World (net of fees)

Source: bfinance, eVestment. Trailing periods to 30 September 2024. Returns net of representative 20bps management fee. Results are not indicative of future performance.